Understanding SEC’s latest FAQ on performance obligations for private funds

Understanding SEC's latest FAQ on performance obligations for private funds

On the 6th of February, 2024, the Securities and Exchange Commission’s (SEC) Division of Investment Management unveiled a new Frequently Asked Question (FAQ) aimed at clarifying the obligations surrounding gross and net Internal Rates of Returns (IRR) in the private markets arena. ACA Global, a GRC solution developer, has offered some guidance highlights the SEC’s commitment to ensuring transparency and comparability in performance reporting.

The FAQ elucidates two critical aspects. Primarily, it sets forth the condition that advertisements must not showcase gross performance without concurrently presenting net performance, ensuring both are given equal prominence and presented in a manner that facilitates direct comparison.

This clarification addresses a common practice among private fund managers of displaying a fund’s Gross IRR, based on investment-level cash flows, alongside a Net IRR calculated from fund-level cash flows, marking a significant step towards standardising performance disclosures, ACA explained.

Furthermore, the FAQ makes it clear that Gross IRR, calculated without considering the impact of fund-level subscription lines, cannot be compared directly with Net IRR that includes such impacts.

The solution proposed requires that both investment-level Gross and Net IRRs, excluding subscription line effects, be presented with equal prominence. This directive aligns with the recent Private Fund Advisers Rule for Quarterly Statements, which mandates the disclosure of Fund Level Gross and Net returns, both with and without subscription line impacts, thus underscoring the need for operational alignment to comply with both sets of regulations.

Moreover, the FAQ addresses the issue of advertisements that only display Fund Level Net IRR, including the impact of subscription lines, cautioning against potentially misleading investors. It suggests that a more comprehensive approach, including comparable performance metrics or detailed disclosures on the impact of subscription facilities, is necessary to provide a clear and accurate performance picture.

This guidance reinforces the SEC’s stance on the importance of full transparency in performance reporting, especially when subscription lines are utilised. It serves as a timely reminder for firms to re-evaluate their current practices in light of the Marketing Rule and consider necessary adjustments.

ACA Global stands unique as the only Governance, Risk, and Compliance (GRC) entity offering both regulatory compliance advisory and performance expertise. The nuances of calculating Gross and Net IRRs, as delineated in the FAQ, are likely to pose significant challenges within the industry, prompting a reevaluation of performance presentation practices.

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